For months, I’ve been telling you that the markets are headed higher.

A side effect is that they would likely take some of our targeted bricks-and-mortar retail losers higher as well, making those crappy stocks appear ripe for a real turnaround.

That’s exactly what we’ve seen – an across-the-board rally that’s inflating the stocks we know are headed south.

Today, I want to take a deep dive into the market rally, tell you why some crappy retail stocks are going along for the ride, and show you why they will not continue to rise with the rest of the markets.

Let’s get started…

Why the Rising Tide Is Lifting These Sinking Ships

Generally, market rallies are led by a handful of so-called “leadership” stocks, who get a lot of attention and capital thrown at them. As benchmarks go higher and higher, they are led by leadership stocks which can consist of a group or a couple of groups doing the heavy lifting. Since November, they have been the big tech names and bank stocks.

Along for the ride, a lot of the ugly-duckling and left-behind stocks start to look like bargains compared to the big names.

What eventually happens is something called a “rotation.”

Investors rotate into “cheaper” stocks when their allocation into leading stocks looks a little too fat. That happens when the prices of the winners leading markets higher rise, the relative weight of those holdings in a portfolio makes them look heavy. There’s a lot riding on them.

Institutional managers start looking for cheap stocks, or “value stocks.” While there’s a difference between cheap stocks and the real value stocks, what matters to investors is their potential to get drawn into the rally.

In a rotation move, cheap stocks get bid up, hopefully enough to draw the attention of other investors who see them on the move. Those investors buy them, believing that as the market continues to rise those stocks will continue to attract capital until they are no longer cheap.

That’s just how a lot of long-running rallies play out. It’s what we’re seeing now, and why some of our favorite short targets are getting bid-up. They’re looking better these days, regardless of whether or not these companies deserve it.

But it won’t last…

The Rally Is Showing Some Weakness

It looks like the markets are slowing their roll and might be ready to take a breather.

The usual headlines are growing old, when every day is “Another record day on Wall Street.” Underneath it, there are signs of fatigue.

First, while the market’s been making new highs, we’re certainly not going gangbusters.

The S&P 500’s been up in eight out of the last nine months, making new highs and headlines regularly. But a hard look at the actual tally reveals that, since March 1st, the S&P’s up a not-so-whopping 3.3%.

At the same time the broad S&P 500’s been hitting records, the S&P Mid-Cap 400 and the S&P Small-Cap 600 have been more-or-less floundering.

As far as the Dow Jones Industrials Average goes, it’s been making higher highs and garnering even more headlines than the S&P 500. Meanwhile, the Dow Jones Transportation Average has been going sideways – and sloppily, at that – since December. It made a new high in mid-July, fell back, and looks like it’s going sideways again.

That’s called divergence. In the case of the Dow Industrials going one way, the Transports going another way (divergence under Dow Theory), and the different action across the S&P indexes, it all adds up to signs of internal softness.

Second, every which way you measure “the market,” it’s pretty fully bought into. Yes, there is a TON of cash still on the sidelines. But, as far as being invested in the market, it’s crowded in there.

With the crowd bidding up stocks, the value of all stocks now is a whopping 142% of U.S. nominal GDP. That’s huge.

The historic average (since 1925) is 62.8%. Just before things started breaking down in 2007, the value of all stocks was 125% of GDP. Back in March 2009, when the rally started, it was 57.6% of GDP.

In those terms, the market’s priced fully. And those numbers are starting to draw attention.

Third, there’s a lot of discussion about passive investing and how huge inflows into those strategies are lifting all boats with the tide… And that many of those boats are nothing more than rafts hanging onto the mothership.

As the leadership stocks, drawing most of the attention and capital inflows, keep going higher, their influence on the benchmark indexes they’re all a part of increases. All the mutual funds and ETFs that track indexes have to buy all the stocks in those indexes to replicate the capitalization or price weightings of the underlying indexes.

Essentially, the big-cap, high-priced leadership stocks get more bid up, and lots of crappy stocks get bought up along with the real winners. Like I said, they’re just rafts hanging onto the mothership.

With all that buying of the underlying stocks in major indexes, markets go higher. At the same time, volatility (as measured by the VIX) heads lower.  Lots of buying with very little hedging – or, protection being sought in the form of investors buying put options – lowers the VIX. The markets look safe.

That’s a double worry for me. Markets look safer at the same time they’re getting stretched.

I’ll be back with you early on Friday to take down what all this means for your existing positions.